Rescuing America: Everything Old is New Again

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Economist David L. Smith offers both a startling prescription and a prediction on how America is to be rescued from its present malaise. (Clue: it's not what Messrs. Bernanke and Paulson propose.)

We need another Great Depression to cleanse America of its excessive debt, through default, restructuring and repayment, and to teach today's Americans the lessons learned the hard way by those who lived through the 1930s: to live responsibly within our means, save for rainy days and retirement, and avoid debt.

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In a recent interview, Northern California-based economist David L. Smith challenged policymakers and media pundits to rethink their prescriptions for the U.S. economy. "Am I the only person on the planet who thinks that periodic recessions are just what this country needs, and that all these cockamamie plans to keep the economy from slumping are setting up (or have already set up) the U.S. economy for another Great Depression?" he asked.

In a line reminiscent of Gordon Gecko in "Wall Street," Mr. Smith asserted "Recessions are good." When asked to explain this rather startling conclusion, Smith explained, "Recessions are good because they force people to trim spending, pay down debt and save. Recessions also discourage lenders from granting loans to un-creditworthy borrowers and weed out bad loans through defaults, all of which has the effect of preventing the accumulation of unhealthy levels of debt, such as we now have weighing on the economy."

Asked if there were any other salutary effects of recessions, Smith added, "Recessions also force companies to trim fat and operate efficiently, and force weak, inefficient companies out of business, freeing up scarce resources for better use. In short, recessions are the market's way of optimizing scarce resource allocation and imposing discipline on an otherwise spendthrift population. This discipline is needed to prevent the accumulation of excessive debt, the unwinding of which has catastrophic consequences in direct proportion to the amount of debt accumulated. Accumulate sufficient debt and Great Depressions result."

David L. Smith is a veteran commentator on the economics scene, as author for the past 24 years of "Cyclical Investing" (http://www.cyclical-investing.com), an economics/finance newsletter, and, more recently "David L. Smith's Cassandra Chronicles" (http://www.cassandra-chronicels.com and cassandra-chronicles.blogspot.com). a freewheeling commentary on global geopolitical, economic and social issues.

The rest of Mr. Smith's interview follows:

"The single-most distinctive feature of a Great Depression is 'cascading defaults' -- borrowers default causing banks to default on money borrowed from their depositors, who, in turn, then default on their loans to other banks, and so on. The most obvious cause of cascading defaults is excessive debt. The U.S. economy is in trouble precisely because of excessive debt. With most responsible borrowers leveraged to the hilt, lenders eager to keep earning interest on their surplus cash were forced to lend to less credit-worthy borrowers, credit-card abusers and subprime home buyers, resulting in record levels of household debt relative to disposable income."

"Now the chickens are coming home to roost. Greedy mortgage lenders and the saps on Wall Street they fobbed off their bum loans to are taking massive writeoffs and begging the Fed, the Treasury and foreigners to rescue them with massive cash infusions. 'Privatize profits and socialize losses' has become the operative system in America today."

"We may be already past the point of no return. The record debt load of American households may be sufficiently burdensome as to cause the cascading defaults prompting another Great Depression."

"We would be a lot better off today if Mr. Greenspan had stopped playing rescuer-in-chief during his tenure in office and allowed market forces to bring about periodic, manageable recessions, thereby preventing the record levels of debt now menacing the economy. Better to have suffered a series of manageable, market-induced recessions along the way, than to pursue a policy of "endless prosperity" culminating in a crushing debt load leading to another Great Depression."

"Regrettably, one of the problems with American democracy, is that no politician or Fed chief, for that matter, will espouse a 'hands off,' laissez faire capitalist approach to the economy, much as they talk a good game of a 'market economy,' the 'invisible hand' and Ayn Rand Objectivism. Whisper the R word and the stampede is on to rescue the economy, with taxpayers left holding the bag."

"However, the solutions policymakers resort to invariably involve the creation of more debt, either private or public. Republicans fixate on tax cuts, which simply create more government debt, in effect socializing the borrowing excesses from the private sector. The Democrats tend to favor government spending as the antidote to recession, with essentially the same effect on the national debt. The Fed's only tool is to print money so as to lower interest rates, providing banks with more money to lend at cheaper rates so as to encourage more borrowing and spending in the private sector."

"What all of these remedies have in common is that they prescribe more debt to cure a patient suffering from too much debt! That's nuts! Welcome to the Mad Hatter's tea party."

"All that these recession-avoiding schemes will accomplish is to delay the day of reckoning and cause a deeper and longer Great Depression when the defaults start cascading in earnest, as they now appear to be doing with: IndyMac, First National Bank of Nevada, First Heritage Bank of Newport Beach, and Bear Sterns."

"The day of reckoning has been postponed for a while by borrowing from foreigners. However, Americans are about to learn the 'Golden Rule': whoever has the gold makes the rules. The day is not far off when foreigners cash in their IOUs for controlling interests in Corporate America. They are already laying the groundwork by lending huge sums of money to the likes of Citibank, Merrill Lynch, Morgan Stanley and other premier U.S. financial institutions. With friends in high places, foreigners will find it easier to overcome jingoistic objections to their purchase of America's corporate crown jewels."

"Sad to say, (and no politician or policymaker will say it) another Great Depression is just what America needs and deserves. (This is both a prescription and a prediction.) We deserve it because we have become a nation of spendthrifts, driven to buy our HD television sets, SUVs and overpriced houses on cheap credit obligingly provided by ambitious foreigners; we don't save; we allow ourselves to be led by politicians with no other interests at heart than preserving their own power, beholden only to greedy corporate executives who pay themselves obscene amounts of money while begrudging working stiffs pay raises, health care and pensions."

"We need another Great Depression to cleanse America of its excessive debt, through default, restructuring and repayment, and to teach today's Americans the lessons learned the hard way by those who lived through the 1930s: to live responsibly within our means, save for rainy days and retirement, and avoid debt."

Smith concluded with George Santayana's famous quote: "Those who cannot remember the past are condemned to repeat it."